That could be said for the entire digital asset market, which has seen more than two-thirds of its value evaporate since peaking at $3 trillion last fall. As the Federal Reserve cranks up its campaign to rein in inflation, investors are dumping risky assets in anticipation of rising interest rates. Startups that soared during the two stimulus-fueled pandemic years have started to fall to earth.
The market’s plunge is likely to temper expectations around a two-year lobbying campaign that has made digital assets one of the most visible industries on Capitol Hill. Crypto’s shrinking footprint could weaken a bid by top exchanges and developers to push for new laws and light regulations that they argue would allow blockchain-based businesses to thrive. And it could damage any trust the industry has accrued in Washington – particularly amid growing scandals on popular lending platforms where customer accounts have been frozen or wiped out.
“When everything’s going up, it hides a lot,” Commodity Futures Trading Commissioner Caroline Pham said in an interview. “From a regulator’s perspective, it really just underscores that we just need to be doing something.”
Top exchanges and industry associations pumped $9 million into Washington lobbying efforts in 2021, more than tripling their spending from the previous year, according to a report by the watchdog group Public Citizen. That drive accelerated through early 2022 and was amplified by tens of millions in campaign contributions from powerbrokers like FTX founder Sam Bankman-Fried.
But the battle to shape legislation and influence agency decisions to tighten supervision of the industry is just beginning, and Caitlin Long, the founder and CEO of a Wyoming-based crypto bank, said some digital asset firms have themselves to blame for growing heat from regulators. The representations that the companies make to Washington policymakers often amount to “regulatory theater,” she said.
“They know they exist in a regulatory gray area,” said Long, who’s suing the Fed to open up a master account that would bring her bank under the central bank’s direct oversight. For some crypto businesses, “the strategy is to get as big as fast as possible; to become too big to be required to comply with regulations.”
That strategy might be too big to work. Market regulators and law enforcement have already targeted areas like insider trading, disclosure failures and investor-protection issues. And regulators, including top brass at both the Securities and Exchange Commission and the CFTC, have signaled that more investigations are likely.
“I hope we use the turmoil of the last couple of weeks to take a look at where we are from a regulatory standpoint,” said Robert Baldwin, a former Treasury official and head of policy at the Association for Digital Asset Markets. While the industry has built credibility with policymakers, he said, recent events “force people to take a step and think about what’s going on. It also probably forces the companies to be a little more prudent.”
Meanwhile, with Congress’s attention divided by crises from Ukraine to inflation, the urgency to pass new crypto laws will probably wane as investors shy away from high-risk digital assets. Even with headline-grabbing celebrity endorsements of crypto businesses, a recent Fed survey found that just 12 percent of American adults had held or used digital currencies over the previous year.
The decline in digital asset markets, which coincides with losses in more traditional financial markets, is accelerating as hedge funds, crypto-based lending platforms and stablecoin issuers scramble for liquidity to salvage their projects.
The latest blowup started last weekend after Celsius Network – a bank-like crypto lender that pledged annual yields as high as 18 percent on customer deposits – announced it was pausing withdrawals and crypto-for-crypto trading services for about 2 million customers “due to extreme market conditions.” The company, which has not responded to several requests for comment, is reportedly exploring restructuring.
Celsius’s woes echoed those of TerraForm Labs – the startup behind an algorithmic stablecoin that collapsed last month – which had also attracted billions of dollars from retail traders and institutional investors by linking its token to a high-yield decentralized lending program.
The market downturn is starting to bring down major crypto investment firms as well. Three Arrows Capital, a Dubai-based hedge fund, is teetering after marking hundreds of millions in losses from its investments in TerraForm tokens and other flagging digital assets.
Both businesses have had run-ins with securities regulators. Celsius was directed by four state-level agencies to stop offering unregistered securities in the form of interest-earning accounts amid fears that the company would be unable to meet its obligations to depositors.
“Policymakers care less about common shareholders and preferred shareholders; they care first and foremost about those depositors,” said Mike Boroughs, co-founder and head of portfolio management for the blockchain investment firm Fortis Digital.
While some decentralized finance (DeFi) lenders – or more centralized businesses hawking access to DeFi-like yields – might offer cheaper alternatives to tightly regulated banks, a lack of institutional underwriting standards injects even more risk into crypto markets.
“If you’re offering higher yield by taking on worse loans, then that just creates a 2008 subprime crisis in a different industry,” Boroughs said.
Crypto advocates have resisted those types of comparisons, arguing that autonomous or community-governed systems that mimic the functions of traditional lenders and exchanges could become safer and cheaper alternatives. And, for now, no existing platform has scaled up to the point where it could pose a systemic risk to the economy.
Lawmakers and crypto proponents say the market volatility could provide an opportunity for certain businesses to spotlight their practices as a potential model for future legislation or rulemaking. Sens. Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) say their recent crypto bill – celebrated by industry as a milestone – was shaped by some of the issues that arose following the TerraUSD collapse.
“We’re kind of in this ugly duckling phase,” said Linda Jeng, a former Fed official who leads regulatory and policy efforts at the crypto industry-backed standards organization Centre. Jeng said she looked forward to working with regulators to “develop appropriate proportionate rational rules and regulations.”
Nevertheless, the arrival of more scandals could create obstacles for the industry as it attempts to make that case around Washington – particularly with new venture capital-backed platforms offering similar services rolling off the conveyor belt.
“If you want to start a successful platform in this space, the current framework is just extraordinarily ambiguous as to how you would go about doing that,” said Tomicah Tillemann, the global chief policy officer of Haun Ventures, a venture firm that recently provided startup funding to a new DeFi lending platform. ”We and others have been calling on the SEC to provide clarification for a very long time, and they have utterly failed to do so.”
SEC Chair Gary Gensler says the rules around crypto lending are clear.
BlockFi, another platform that’s recently withstood layoffs, paid $100 million to settle claims that its yield-generating accounts were unregistered securities. Coinbase scrapped plans for a product that would have allowed customers to earn interest on their digital assets after a highly public spat with the regulator last year. The agency was reportedly investigating Celsius – as well as several other crypto lending platforms – in the months before it froze its customers’ assets.
An SEC spokesperson declined to comment on whether there are any pending investigations.
“Lending platforms, they’re operating a little like banks,” Gensler said at an event on Tuesday, adding that trading platforms and exchanges offering sky-high yields have largely failed to disclose enough information about their products to investors.
“If it seems too good to be true, it just may well be too good to be true,” he said.